So far the equity markets have ignored the "rate ratchet," causing one frustrated Wall Street wag to lament, "Hey Jeff, I am afraid of this market because it is overvalued, over-extended and overdue for a correction, yet I have to play the long side since my performance has to keep up with 'the Jones,' the Dow Jones that is, so what am I to do?!" As stated in last week's verbal strategy comments, our friend Barry Ritholtz, eponymous captain of Ritholtz Research & Analytics, asked, and answered, this same question in a report titled, "How to Play the Long Side Safely." In the report he cited a few parameters: "1) Identify strong sectors with good money flow; 2) Look for stocks within those sectors with desirable risk/reward characteristics; 3) Screen for stocks with the best technical, fundamental and earnings potential; 4) Find stocks that are near good entry points; 5) Avoid 'runaway momentum' names; and 6) Look for stop loss protection that is a reasonable downside away."
To these points, we have been using Johnson & Johnson (JNJ) since $60/share. We have also used Quadra Reality (QRR), which is rated Outperform by our research correspondent Credit Suisse. Since we have elaborated on these stories in past missives, we won't reiterate them this morning. What we have for you today are a couple of new risk-adjusted ideas. First is MeadWestvaco (MWV) that Credit Suisse issued a trading alert on last week stating, "We are establishing a long position in MWV shares. The catalyst for this trade is expected updates on the timberland sales and the $200 million annual cost savings initiatives over the next month." However, as noted by Glenview Capital's founder Larry Robbins at the recent Ira W. Sohn conference, there is more to the MWV story than that. To wit, while the land business is only 4% of EBITDA, Glenview thinks it is 21% of the company's value and should be monetized. They calculate that the 1.1 million acres is worth at least $2.4 billion. Further, they think the specialty chemical business should be sold and the office business merged. If done, Glenview believes valuations could reach $47. Given their view that the downside is roughly $30/share renders an upside risk/reward ratio of 2.4 to 1. With a 2.6% dividend yield, we find MeadWestvaco intriguing.
Another investment idea from our universe is 3% yielding, Outperform rated, Flagstar Bancorp (FBC). With $15.4 billion in assets, Flagstar is the largest savings and loan institution in Michigan. It is also one of the nation's top-30 mortgage originators. As such, the consternations in Michigan have left these shares down some 54% from their March 2004 high and selling near book value. Yet, Flagstar does not have much sub-prime exposure, and while the mortgage business is still a focus, Flagstar is using the cash flow from the mortgage operations to expand its retail branch banking network. Indeed, FBC has opened numerous new branches in excellent locations, which is consistent with the history of this savvy management team.